Slump in Wage Growth Won't Bring Deflation

The decline of wage growth was the most puzzling aspect of Friday’s otherwise strong U.S. jobs report. Based on the entirety of recent macroeconomic data, this is more likely to be a short-term blip than a harbinger of damaging deflation. But it does point to stubborn and deep-rooted challenges that still confront the U.S. economy.

There was nothing not to like about the jobs dimension of the report for December: The monthly payroll gain of 252,000 again exceeded consensus expectations and marked the 11th consecutive month of job gains of more than 200,000. It also was bolstered by favorable revisions to prior months (including the addition of 32,000 jobs to November’s “wow” estimate).  The unemployment rate maintained its downward trajectory, closing the year at 5.6 percent, compared with 6.7 percent at the end of 2013.

The report reinforces other macro indicators pointing to America’s improving economy. But it didn't ease, at least yet, worries that this recovery remains insufficiently inclusive, especially given the 0.2 percent decrease in hourly earnings that pushed down the 2014 increase to just 1.7 percent. And with deflation already a real and present danger for Europe and Japan, the December decline in America's wages is fueling concerns that the U.S. may be on a similar path, a prospect that would compound longer-term growth challenges and postpone Federal Reserve rate increases into next year, if not beyond.

Even so, it is too early to extrapolate deflation from the monthly drop in wage growth, and it would be premature to see it as evidence the Fed's first rate increase will be delayed.

The estimate conflicts with what would be expected given the U.S. robust job creation. It is also inconsistent with a number of other indicators, including the decline in the labor participation rate; the fall in both the conventional unemployment rate and the U-6 measure that uses a broader definition of who is unemployed; growing consumer and business confidence; and the difficulties that the 2.8 million long-term unemployed are having regaining jobs.

That's why I suspect last month’s wage contraction will ultimately be seen as an anomaly. But it does point to a broader secular concern that should compel Congress to make a much greater effort to increase the country’s growth potential and render it more inclusive.

For more than a decade, anemic wages have been part of a set of entrenched  and increasingly structural forces that have contributed to a sharp increase in the trifecta of inequalities (of income, wealth and opportunity). These have weakened aggregate demand growth and discouraged business investment. They also are gradually undermining social cohesion by hollowing out the middle class.

With the U.S. having regained almost 3 million jobs in 2014 and reduced its unemployment rate to the lowest level since June 2008, attention now turns to the price side of the labor market. Restoring dynamic wage growth is an important challenge for the longer-term well-being of both the country and the global economy. To meet this challenge, the U.S.  will need more than a cyclical recovery in jobs — as impressive as that continues to be.